New Worry: Double-Bubble Pop

I read Matt Taibbi's excellent conspiracy theory/article about Goldman Sachs this weekend (Rolling Stone; "The Great American Bubble Machine"). He blames Goldman for every bubble since the Great Depression; from dot com to oil. While I love a good conspiracy theory I find it impossible to blame Goldman alone. One large player may be able to manufacture and hype a bubble but, as I said yesterday, it takes hundreds or thousands of players to inflate one. Other (former) investment banks are equally to blame. The new/old bubble - commodities - is currently being hyper-inflated by a weak dollar. The weak dollar is being caused by the US government printing money to pay for the prior excesses of the American pubic, which of course includes the banks. It is hard to see how this scenario can change in the medium term, which is why every retail investor, institution, bank, fund and hedge fund is going long commodities. (The plus side is that $4.00 gasoline will finally force Americans out of their SUVs - and to sell their dreaded ATVs.)
One has to worry about a double-bubble pop scenario. The credit crisis is anything but over, and there are hidden landmines within many banks' balance sheets. Why did ABN Amro's CFO go out into the woods and top himself, if there is nothing left to hide at ABN/RBS? (Apart from the Wimbledon suite, but that got out anyway.) If everyone goes long commodities and is hiding gazillions of dollars of further losses in credit derivatives, we could be facing a two-bubble pop. Ouch.

You Can't Regulate Against Stupidity

The Bank for International Settlements has released some new guidelines for financial instruments, the 'new normal' according to Financial News. BIS says that complex structured products such as risky derivatives should only be marketed to suitable sophisticated investors. BIS likens these to pharmaceuticals, where the availability of prescription drugs is controlled. On the surface this sounds like a good idea but, like prescription drugs, you cannot control the demand from unauthorized parties. With drugs, teenagers and pushers will raid parent's medicine cabinets and steal from hospitals to satisfy their needs. With complex derivatives there will be a similar pattern. The banks will create the newest 'bubble' product and rake in the cash. A pension fund in Iowa will see how well investment banks are doing trading the 'hot' product and will want it for its clients' portfolios. Like a pusher, some middleman somewhere will ensure they can get it. The fund will load up with inappropriate instruments and will unlikely be able to manage the risk properly. Banks win, pensioners lose. The banks love complex financial instruments for this reason. And they need to get them out to the financial market equivalent of teenagers and users for this reason. It is difficult to make gazillions on OTC derivatives if you can only trade them with a handful of other players. And impossible to create another bubble.

SIFMA Lite

SIFMA's Technology Management Conference and Exhibition in NYC this week was a shadow of its former self. Battered by the economy and budget cuts, technology firms stayed away in droves. The exhibition was spread thinly between two floors where it once thickly covered three floors. On Wednesday, even at lunchtime, the crowd was sparse this year. Previous years' biggest exhibitors included Reuters, which didn't show this year due to a reported spat with new owner Thomson. It seems The Reuters people wanted their own booth, as did Thomson's ILX chaps. The result was none. Interactive Data Corporation took the space that Reuters previously occupied. SunGard did its own thing with a half-day mini conference at another hotel. There seemed to be a plethora of data vendors there, both new and old. Some, like TradeTheNews.com, targeting retail investors. Some, like Acquire Media (which bought NewsEdge where I once almost worked) and Dow Jones (where I did work), are focusing on elementized news for algorithms. There were also plenty of algorithmic trading solutions providers to be seen, they seemed to be the happiest of the lot and said that business was brisk despite the downturn. Progress Apama had a jazzy booth with a splendid magician. He guessed the last four digits of my Social Security number. And, no, I was not a "shill" as someone suggested. Sybase had a cipher/magician who was also incredible. There was a serious dearth of good swag this year. I guess good corporate gifts are too expensive for today's fragile budgets. FTEN had a super dinosaur squeeze toy and Tibco (are they still around?) gave out a useful tiny tool kit. Otherwise it was mostly pens and business card raffles for iPods and such.
The party scene was still opulent, on the other hand. Portware unveiled a new advertisement on a Times Square electronic billboard and hosted a do at the Blue Fin bar. SunGard's shindig was on top of the Empire Hotel, where one could view the ongoing construction site that is Manhattan. There were many, many techies well on their way to terrible hangovers there. On Wednesday evening Fidessa held a cocktail in a beautiful bar inside an old church, appropriately called 'Providence'. And KX snagged a nice little bar near Gramercy Park, which was packed.
My journalistic colleagues were out in force as usual, after free drinks and interviews with the usual suspects. I had a quick look through the publications on the table in the entry hall and it occurred to me that the old business models are looking very tired indeed. Monthly and even weekly magazines with dated people moves and self-serving contributed articles are surely past their sell-by date. The mainstream media has latched on to our old patch, and coverage of financial markets and technology is now instantaneous and widespread. I think we need a new niche.
SIFMA itself might have to rethink its tech conference model. Some previous exhibitors claimed not to like SIFMA's 'anyone goes' attitude. Letting in all and sundry does not usually create business opportunities for the vendors and ideas can be stolen. Perhaps SIFMA could adopt the DWT (Dealing With Technology) model for conferences - no vendors allowed unless exhibiting. When I was there DWT only allowed customers to attend, which gave the vendors more incentive to pay the price for a booth. The world has changed, now our industry has to catch up. That goes for the conferences, the software firms, and the publications. SIFMA this year made that much, at least, very clear.

Exposing Dark Pools

The SEC is looking into dark pools to see whether they might be considered a threat to market transparency and is considering regulating them. Chairwoman Mary Schapiro said that a "lack of reliable information can prompt speculation and suspicion about the basis for market fluctuations.” This may be true. But it would be a mistake to over-regulate dark pools. They came about quite naturally - either for trading large blocks without unduly moving the market or for internally crossing a large bank's business. Now dark pools are big business. The banks upsell access to their internal pools, a myriad of independent technology platforms have been launched for dark pools, and dozens of software firms have developed solutions for them. This includes smart order routing to find the best price or volume, and algorithms that find liquidity inside or outside the pools. A large segment of the financial technology business would suffer if dark pools were banned or exposed.
On another note I am off to the SIFMA Technology Management Conference and Exhibition in NYC tomorrow. I am told there are a lot fewer exhibitors this year due to budget concerns. (That will mean less swag, presumably.)But there are some fancy parties: On Tuesday Portware has a cocktail reception at the Blue Fin Bar, Thomson Reuters is hosting a panel discussion and wine tasting, and the ubiquitous SunGard party is at the Empire Hotel rooftop. Wednesday night includes a Fidessa party and KX Systems, which is down in the Gramercy Park area - a nice change from midtown. I will blog all the news from SIFMA on Friday.

Glencore Execs: Show me the Money

I never thought I would hear these words: 'Glencore explores market flotation'. Glencore, the uber-secretive, hyper-profitable offspring of Marc Rich, wants to become a public company. With analysts and stockholders and regulators looking down its throat for possible cancerous cells? I don't think so. Glencore makes its money by being more nimble than the next guy, quicker to find a niche market. This is almost impossible to do if you are a public company. The methods necessary to do business in oil, metals, and other 'frontier' physical commodities markets are not appropriate for public companies, no matter where they are listed these days. (Even the Swiss regulators are getting more conscientious about the activities of their brood.)My sources say this flotation idea may have been been 'leaked'. During the credit crisis, when Glencore's credit default swaps went through the roof due to concerns over its liquidity, the partners decided to substantially defer bonuses and so-called cash-ins. Glencore employees get most of their bonuses as a cash-in payoff when they leave. If they leave today this cash-in will reportedly not happen for some years. It looks like someone wants his money now.

When Windmills Tilt Back

President Obama unveiled his regulatory reforms this afternoon, none of which were really surprising. The Fed will have greater oversight of the existing regulators, which will mainly remain intact apart from the Office of Thrift Supervision (which clearly was useless in the run-up to the credit crisis). It will also oversee the larger 'too big to fail' companies which includes a couple of insurance giants. It is absurd that most insurance companies will remain under the supervision of their home states. These firms are some of the largest speculators in financial markets and there is no chance that a state-based agency can spot problems or irregularities. The President said this morning on CNBC that he didn't want to go 'tilting at windmills' by consolidating the existing agencies. Hopefully the new regulations go far enough and are policed carefully enough by the hodge-podge of regulators. The windmills to watch out for are the banks. They have enough firepower with Congress to hamstring anything they don't agree with - like enhanced capital requirements. S&P already downgraded a bunch of them. Expect to see banks tilting back.

Rationalizing Versus Rational

Commodities and stock markets are 'puking', as traders like to say, after the US Treasury secretary and UK chancellor said that it was too early to call 'green shoots'. The fact that economists, traders, analysts and bloggers have been saying this for weeks appears to have eluded the market until now. The herd mentality took commodities and stock prices up purely based on the whole green shoots sentiment. (If recovery is nigh, buy buy buy. If the economy goes to Hell, sell sell sell.) The Financial Times reports today that financial analysts are baffled by the recent behavior of the markets and that it contradicts the 'efficient markets' theory. I disagree. An efficient market is one which does what the participants want. If they want to believe that the credit crunch is over and Hummers will again rule the road, they will buy oil. If they don't, they won't. The fundamentals rarely enter into it anymore. The fact that oil has been massively oversupplied has had almost no impact on prices over the past three months. If the market thinks that the banks have turned a corner and are now safe, sound and financially viable they will buy financials. If they don't, they won't. The fact that banks still own some seriously dodgy assets? Again, it has little to do with it. Efficient? Yes. Rational? Not on your life.

The Herd Mentality

There is an old saying in the financial markets and it goes something like this: when the majority of traders and headlines agree that the market is going up or down - that is when it changes and does the opposite. Last week the Trade Idea Monitor from youDevise noted that 73% of institutional brokers were recommending that their clients go long. The number of long ideas compared to short was up by almost 100% from the week before. Bears finally turned the corner and said 'OK, I guess this isn't a bear market rally after all. It is the real thing.' Then, wallop! Monday morning comes around, the Kool-Aid hangover kicks in and the market plummets. I have long suspected that traders and investors are sheep-like in their behaviour and my friend Gerald Ashley explains it nicely in his book 'Financial Speculation': "The herd atmosphere amongst fund managers is so strong these days, and the fear of scrutiny from outsiders so great, that they seem to prefer to act together and be wrong, rather than risk being different, original and creative."
And for those sheep out there who believe that the banks have truly repented and are now on their merry way to loosening up credit, I have one thing to say. Refinancing my house has now been underway for 60 days and counting. The bank in question is doing its absolute utmost to drag its feet so as not to give me the 4.875% that I locked in for 90 days. My husband and I make good money, have excellent credit ratings, and are in no way overextended. I get the impression they are trying to hang onto their money until interest rates go up. FDIC take note.

The Regulators are Trying to Herd Cats

Timothy Geithner is about to unveil a new regulatory regime in the US that will probably include two more levels of bureaucracy, according to the Financial Times. One will likely be a council of the heads of all the big regulatory bodies, the other a structure to watch over credit card and mortgage companies. While I applaud the effort, and have been a strong supporter of better regulation especially with regards to risk management, the proposed structure is unlikely to help. Regulating and monitoring financial services firms is akin to herding cats. You get them all corralled with the promise of Fancy Feast (TARP money) and then one-by-one they find reasons to wander off in different directions. With or without eating said cat food (or immediately regurgitating it - again TARP money). The reason? There are some big, fat mice out there to catch (read: new markets, bubbles, or derivatives). The problem with the regulators is that they are always one step behind the cats, or the smartest guys in the room in financial markets terminology. The reason they didn't cotton on to the impending credit crunch and various Ponzi schemes is because they inherently believe that people are honest, that they abide by the regulators' rules. They do and they don't. Scratch the surface of compliance and you will find a virtual can of 'getting away with it' worms. Regulators can only go so far without violating privacy laws or something. What I'd like to see is fewer regulatory agencies with more power and more investigative experts - say,ex-traders who like conspiracy theories. With super-duper snooping technology like complex event programming that can be programmed to dip in and out of the markets and detect patterns among certain trading firms. I'd like the regulators to be the smartest guys in the room.

Blankfein has 20/20 Hindsight

Lloyd Blankfein, CEO of Goldman Sachs, told a conference yesterday that using fair value accounting might have prevented the credit meltdown. Duh! Ya think? It is not like the SEC and Bank for International Settlements were not pushing fair value and mark to market, they were. And companies like Reuters and Markit were working like mad finding ways to value those hard-to-price instruments. All of the ingredients were there, what was missing was the will to implement them. Taking risky assets off balance sheet meant that they sat there quietly corroding. Stress tests were only done to the limits of what young, business school graduates considered within the realm of possibility. Fat bonuses meant that the status quo was not questioned from above. I hesitate to bring it up again, but moral hazard risk remains the most dangerous of them all. It led to the problems we are now facing, and has so worried the authorities that they are going to mandate bonus structure. RULES and LIMITATIONS on your bonuses! Look what you've done. Ignore risk at the peril of your paycheck.

God, Guns, Gold and Glencore

Historically there have been three core values that Americans fall back on: God, guns and gold. When the going got tough they went to church, hoarded gold and holed up at home with a Remington rifle or two. To this mix we can now add Glencore. Glencore and Credit Suisse have just announced an index that will be based on Glencore's traders' views of the markets they trade. The Glencore Active Index Strategy will track 20 major commodities based on votes from Glencore's traders.
Glencore, the Swiss-based now-orphaned offspring of tax-dodger Marc Rich, is one of the largest traders and suppliers of commodities in the world. It has its fingers in pies from metals to oil to agricultural products. Its traders are highly regarded as being the best of the best. So if they don't know what the markets are doing, no one does. I'm not saying they always get it right - they had a few hairy moments during the credit crisis when all of their long position prices went in the toilet - but for the most part.... I intend to invest in this index.

On the Fiddle

The expenses abuse row in the UK is exploding into tiny little sparks of discontent that are being fanned into raging fires all over the country. It seems the average Labour supporter - let's call him Joe Fish 'n Chips - is outraged that his MP might have spent taxpayer money on moat cleaning. The US Congress, presumably in a preemptive CYA move, is preparing to offer up its expense accounts online for better 'transparency'. When I began my career in the early 1980's, an expense account was considered part of your salary. When you were paid tuppence ha'penny to work 50 hours a week, a nice dinner out on "Mother XX (your firm's name here)" was one of the few benefits. As times got worse, journalists' expense accounts were pared to the bone. Taking a source to lunch was so painful (pre-justification, approval of restaurant, maximum per-head limits) that we just waited until someone invited US out.
I remember when I was working at Platt's, my editor-in-chief Halsey Peckworth told me a story about an FBI man who went on a business trip to Russia. When he got there it was cold and rainy and he didn't have a raincoat. He bought one and duly put it on his expense account. J. Edgar Hoover sent his expense form back to him with a note that said "The FBI does NOT pay for raincoats." The agent re-did his expense form and sent it back up for approval with his own note: "Now find the raincoat." Brilliant. Halsey and the rest of us lived by that philosophy for as long as we could get away with it.

Facebook for Executives

According to Finextra, NYSE Euronext has launched an online 'community' for executives of NYSE and Amex-listed companies. The community is going to offer them the opportunity to collaborate with peers to share ideas, and get access to each others' blogs and other information. When I heard this I had to laugh. I can just imagine an exec at Bank of America sending a virtual prayer stone and an "OMG" to his counterparts when financials hit the skids in the market. Or a Citi exec sending out a "Thank God its Friday" message with a "Smile". haha.
What I'd LIKE to see is an exec at a bulge bracket bank sending out queries in the morning that go like this: "What shall we do today? Spook the market by selling off financials and then run back in to scoop up our own shares later in the day at a cheaper price?" Or this: "Could someone please make sure Jim Rogers gets on CNBC this week and hypes commodities? We are looonnggg!" "Smile".
Speaking of commodities hype, hedge fund manager Michael Masters spoke to the Senate Agricultural Committee yesterday and told them that nothing had been done to stop another oil bubble from happening. Which he thinks has already started. Another oil bubble is good for me, it might help to sell my book! I'm not so sure it is good for the economy.

The Cheetah Theory

The Cheetah theory of trading says that the best traders will wait until they are absolutely certain of catching their prey before they strike. The theory, attributed to the mysterious 'master trader' Mark Weinstein (who was profiled in the book Market Wizards; Interviews with Top Traders), is all too relevant today. The cheetah, the fastest animal in the world, can be represented in the equities market by high frequency algorithmic traders. Their algorithms lurk on the sidelines until the market conditions are just right then they strike. The cheetahs' prey,the gazelle, zigs and zags because he knows that the cheetah can only catch him if he runs in a straight line. The gazelle can be represented by canny investment managers with their own algorithmic trading systems. The prey that actually gets eaten, let's call them wildebeests, can be represented by less energetic fund managers or retail investors. So what we have in today's market, where something like 70% of the daily volume comes from high frequency trading, is cheetahs and gazelles running in circles. And the Wildebeests are still getting killed when they enter the market. The cheetahs and the gazelles are winning a little bit day-by-day while the weary Wildebeests are increasingly staying at home. This means that the so-called 'dry powder' (CNBC, of course) of billions of uninvested money is still not coming onto the market. I wonder if this is a permanent trend.

The Rebirth of the Commodities Bubble

The next asset class bubble appears to have emerged already from the ashes of the credit crunch. It is commodities - again. Since the beginning of the year crude oil has risen by more than 50%, copper by 65%. The speculators are back armed with facts and figures abut increasing demand from China. This time, however, those with actual exposure to commodities risk are racing to hedge that exposure. According to Greenwich Associates, in 2007 only 45% of firms hedged the risk - and we know where that led. Now, said the consultancy, 55% are in there hedging. This is still a fairly low number in my opinion. Speculators will ride this latest bubble all the way to the top, while 45% of firms with commodities exposure will get their faces ripped off. An oil trader I know said: "There is no rhyme nor reason for oil prices to be going up. But it is the same scenario as last time (2007) and I am going to ride it all the way up. You don't stand in front of a moving freight train."
The new chairman of the CFTC, Gary Gensler, went in front of the Senate Subcommittee on Financial Services this morning promising to keep a weather eye on the speculators. But the regulator needs money and it needs experienced staff to do this. I recommend they give him the money, he is going to need it - soon.

Bubble, Bubble Toil and Trouble

I spent the past week finishing the book I am writing, it is a novel about a conspiracy to raise oil prices complete with murder, mayhem and the obligatory sex scene. Conspiracies are a popular subject in financial markets, not without cause. In the oil market price fixing and collusion is as rampant today as it was when the US "Seven Sisters' oil majors dominated the world's markets. (It is just less obvious.)
But usually the reasons behind a market move are pretty simple: people buy when the market is going up and they sell when it is going down. It is human nature. The next best thing is whatever stock or asset class is rising quickly. This is what causes asset class 'bubbles'. There is talk that regulators are trying to figure out a way to stop bubbles from happening. They might as well use donuts to try and to stop flood waters from rising over a river bank. People like bubbles. They like identifying something that might make them money, then they jump into it head first and hold on until the bubble pops. That is what happened with the dot coms and then housing. The next bubble is what will help to pull the world out of the recession. And you can be certain that if the investment banks put their minds to it (and I am certain that they have already) they will create the next new bubble and make oodles of money on it.